CHICAGO'S FUTURE IN FUTURES

Presented at the 23rd Annual Fall Management Conference, Northwestern University,
Evanston, Illinois,
November 7, 1973.

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The primary requirement for success of the IMM was the unwavering support of our members. Thus, the results of our first year were critical. To our relief, we were able to proudly point to our achievements and bravely talk about the new era the IMM represented. The 1973 Annual Report to the IMM membership reflected this belief. In it, I unabashedly stated to IMM members that "The new era will afford us the opportunity to expand our potential into other areas within the monetary frame of reference.  That was the essence of the philosophy that fostered the IMM.  Our new market was specifically designed to encompass as many viable trading vehicles in the world of finance as practicable.  We must be willing and ready to explore all possibilities."

The results of our first year also gave us courage to explain to our immediate community what was happening at the Chicago Mercantile Exchange. This was no idle task. Success of our ambitious IMM plans—in great measure—depended on the support of Chicago's establishment and its leadership. It was imperative that we spend time at Chicago's two prominent academic institutions: the University of Chicago and Northwestern University.

The theme delivered here was central to the message we reserved for Chicago. Our city was special, its citizens were innovators, and its institutions vibrant. Of particular importance were the futures markets of Chicago. They were inventive, successful, and expanding. What's more, they represented an economic engine that could lead our city to greatness.

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Much of what happens is by accident;

Much of what happens is by design;

Much of what happens is a combination of both.

A city lives or dies, prospers or fails as a result of both accident and design but particularly as a result of what its inhabitants do with what they have. Let us read from the Book of Genesis:

After two whole years, Pharaoh dreamed that he was standing by the Nile, and behold, there came up out of the Nile, seven cows, sleek and fat, and they fed in the reed grass.

And behold, seven other cows, gaunt and thin, came up out of the Nile after them and stood by the other cows on the bank of the Nile, and the gaunt and thin cows ate up the seven sleek and fat cows, and the Pharaoh awoke.

And he fell asleep and dreamed a second time; and behold, seven ears of grain, plump and good, were growing on one stalk.

And behold, after them sprouted seven ears, thin and blighted by the east wind.

And the thin ears swallowed up the seven plump and full ears.  And the Pharaoh awoke, and behold, it was a dream.

And after Pharaoh summoned Joseph to interpret the dream, Joseph said to Pharaoh:

There will come seven years of great plenty through-out all the land of Egypt, but after them, there will arise seven years of famine.

And Joseph proposed:

Let them gather all the food of these good years are coming, and lay up grain under the authority of Pharaoh for food in the cities, and let them keep it.

That food shall be a reserve for the land against the seven years of famine that are to befall the land of Egypt, so that the land may not perish through famine.

Thus, the concept of a futures market was born. Joseph's idea saved the day.  Egypt would place forward buy hedges during the period of over-supply in order to provide for their needs during the period of under-supply. Alas, Joseph and the Pharaoh did not go far enough.  They failed to grasp the full magnitude of Joseph's innovation.  They missed their chance to open the First Nile Board of Trade. Indeed, it would take centuries before the concept would fully crystalize and be utilized to the full scope of its potential. Indeed, it required the resourcefulness, wisdom and vision of Chicagoans to put Joseph's concept to work.

Was it an accident that happened in Chicago? Was it some grand design? Or was it a combination of both? We could discuss these questions at length.  We could examine them philosophically or logically.  But they are of no great concern to us now.  What is important is that it happened here.  As a result, today Chicago is the capital of the world's futures markets.

In the first ten months of this year, 903,000 hog contracts were traded at the Chicago Mercantile Exchange (CME) equalling 144.5 million hogs with a monetary value of $11.2 billion. During the same period, 1.2 million wheat contracts were traded at the Chicago Board of Trade (CBOT) equalling 181.6 million tons of wheat with a monetary value of $23 billion.

A city grows by adjusting to changes and bending with the constant flux of time.  To survive, it must fit and meet the needs of the present. In Chicago, the stockyards are gone.  But, in 1972 at the Chicago Mercantile Exchange, approximately 1.4 million cattle contracts were traded, the equivalent of 48 million head of cattle amounting to a value of approximately $20 billion. We no longer store grain in Chicago.  But, in the first ten months of this year, the Chicago Board of Trade recorded approximately 7 million transactions of wheat, corn and soybeans, the monetary value of which is upwards of $170 billion.

Need we explain the significance of these markets?  Need we spell out their benefits to our city, country, or the world? Suffice it to say that futures markets are now an integral part of the agricultural structure of this country.  Suffice it to say that the benefits are of such scope and magnitude that one would be hard-pressed to enumerate and evaluate them all.  Suffice it to say that futures markets provide our nation with a unique economic tool that cannot be duplicated in any other form.  Suffice it to say that its users are diverse and everywhere. Futures serve as an insurer, act as a barometer, function as a stabilizer of prices, operate to level out supply, provide a consensus prediction, stimulate competition, perform as an educational institution, catalog and disseminate statistics, work for both the consumer and producer, aid in the marketing of food products, and, at the same time, offer speculators the opportunity to test their ability against the wiles of the price gods.

Suffice it to say that U.S. commodity futures exchanges are part and parcel of the most successful system of agriculture and marketing in the world.  A system whose productivity has more than trebled in the last twenty years.  A system that is the marvel and model for the rest of the world. Indeed, it is with a great deal of pride that we in Chicago can boast of having the two exchanges that account for over 80% of this nation's futures business.

Can we fully evaluate what this means for Chicago?  Can we fully assess what $66.1 billion worth of transactions on the CME in 1972 and $123 billion worth at the CBOT means to the financial infrastructure of our city?  Can we fully estimate the value of the daily margin deposits to our city banks? The CME alone currently deposits $100 million per day.  We estimate that between the Chicago Board of Trade, the Chicago Mercantile Exchange and the International Monetary Market (IMM), the cash deposits to Chicago banks on any given business day amounts to approximately $400 million.  And margin deposits are but a portion of the total deposits held in Chicago by the member firms of these markets.  Can we calculate the economic thrust generated by these deposits?  The financial services?  I leave that to the bankers. Moreover, these figures will easily be doubled in 1973.

As a matter of fact, there are those who estimate that by 1980, the futures business in the United States will have increased five-fold.  This would mean that the Chicago Mercantile Exchange, the Chicago Board of Trade and the International Monetary Market should be generating about $2 billion in margin deposits at Chicago's banks.  If this estimate is extreme, remember that an increase of only 1-1/2 times present levels—a considerable slowdown of our present rate of growth—would still account for $1 billion in daily margin money deposits for Chicago banks.  A sizable figure by anyone's standards.

What is abundantly clear is that Chicago's futures markets are an important and integral part of our nation's agriculture, while also a significant financial engine in this city's infrastructure.  Of equal import is the fact that in this field of business, Chicago is second to none. So can we rest on our laurels? Should we be satisfied with the growth of our Chicago's markets during the past decade? Volume on the CME alone has risen by 1690% since 1963.  One could conclude that we could take a well-deserved rest and enjoy our successes. If we did, it would not be the way of Chicago. 

It was with good reason that Nelson Algren called Chicago "City on the Make."  Chicago has a restless soul.  It is forever probing new vistas, new frontiers.  This is the spirit that has made us great and leads us to an even greater destiny. This is the essence of our future.  And when Treasury Secretary Shultz visited Chicago several months ago he made a remarkable statement. He stated he was proud of his Chicago heritage because most of the important new ideas emerging during the last two or three decades were either born in Chicago or were conceived by Chicagoans.

Chicago's futures markets are true to this tradition. Not satisfied with their phenomenal growth, they gave birth in 1972 to two new and highly innovative concepts that may prove to be of revolutionary significance in the growth of Chicago as a world financial center. The Chicago Board of Trade inaugurated its Chicago Board Options Exchange and the Chicago Mercantile Exchange, its International Monetary Market.

Allow me to dwell upon the latter, I know of it first hand. We believed that our idea for a futures market in foreign currency was quite good. We convinced our Board members and our membership that it was a concept on which we could build the International Monetary Market and the future of the CME. We were, however, now faced with the formidable task of translating the idea into practicable application. To implement it we needed a helping hand from yet another Chicagoan, Dr. Milton Friedman. It was Dr. Friedman who gave us the courage to believe we were onto something big and worthwhile.  And it was his unquestionable prestige and credentials that opened doors for us in Washington and enabled us to state with confidence that a futures exchange for foreign currency was a necessity whose time had come. 

Listen to what he wrote in his position paper on this subject upon the fall of Bretton Woods:

Admitting that there is now a spot and forward market in London, Zurich and New York, but it has neither the breadth, nor the depth, nor the resilience that is needed.  A really satisfactory futures market cannot depend solely on hedging transactions by persons involved in foreign trade or investment... The market needs speculators who are willing to take open positions as well as hedgers.  The larger the volume of speculative activity, the better the market and the easier it will be for persons involved in foreign trade and investment to hedge at lower costs and at market prices that move only gradually and are not significantly affected by even large commercial transactions.

The changes in the international financial structure will create a great expansion in the demand for foreign cover.  It is highly desirable that this demand be met by as broad, as deep, as resilient a futures market in foreign currencies as possible in order to facilitate foreign trade and investment.  Such a wider market is almost certain to develop in response to the demand.  The major open question is where.  The U.S. is a natural place and it is very much in the interest of the U.S. that it should develop here.  Its development here will encourage the growth of other financial activities in this country, providing both additional income from the export of services, and easing the problem of executing monetary policy.

One must fully comprehend the magnitude of our undertaking to assess and evaluate its progress and success.  What we did was revolutionary. What we did was journey into uncharted waters. What we did was to enter an arena that was the private and sacred shrine of the banking community.  What we did was to design an economic tool that had been previously used exclusively in agriculture. What we undertook was to explain the meaning of Bretton Woods and the significance of its breakdown. What we undertook was to teach the American public about a investment vehicle heretofore unknown on the American shore.

We knew it would be a long and hard lesson about a new order, a lesson we ourselves were to learn as we went along. Because we were dealing with a new commodity, there were no rules, no frame of reference. Predictably, our market has already experienced a number of significant changes.  It has been subjected to modifications brought about by our own learning process and daily dealings with this new vehicle of finance, one that previously was the sole possession of gnomes of Zurich, London and Frankfurt.

Why, we asked should this be so? By what right should European centuries old markets be the sole determinants of the value of the dollar?  Why should there not be an equally resilient market on the American shore?  And, why should such a market not serve both the business community as well as the public at large?  As a matter of fact, the market we had in mind would only work effectively when there was a real interaction between speculative and commercial interests. Such a market would act as an alternative to the interbank market.  Such a market would force foreign exchange rates to become more competitive and realistic. Such a market could become liquid much farther out into time. 

In the beginning, New York banks and bankers considered the project too ridiculous to consider seriously. Today, the New York banks look at our venture in an entirely different light. Today, for instance, both the Chase Manhattan and the City National Bank of New York deal directly with our market.  In Chicago, we were accepted from the very inception. Not only were we assisted by all the major Chicago banks, the Continental Illinois National Bank became our foreign exchange delivery agent and the First National Bank of Chicago became a clearing member. Moreover Mr. A. Robert Abboud, Executive Vice President of First National, and Dr. Beryl Sprinkel, chief economist of the Harris Trust became members of our Board of Directors.

To us it was obvious.  If we were right about the need for such a market, then it belonged in Chicago—the capital of futures markets. It would be a long, long time before our market fully blossomed, but from the start we were certain that the result would be worth the effort. What spurred us on was the magnificent potential of the concept. Finance was, after all, limitless in its application.

To date, the evidence continues to mount that our idea is in synch with the new world monetary standard. Indeed, when the IMM began, all we looked for was a world in which rates would annually fluctuate up or down against the dollar by as much as 2-1/4%.  We soon learned that such would be its hourly rate of fluctuation. Today, barely eighteen months after the IMM's opening, we have every reason to be proud of its achievement and are certain of its immense potential. In our first year, there were 142,928 IMM transactions amounting to a value of $21 billion.  In the first ten months of 1973, there were already 249,345 IMM transactions.

Accordingly, we believe the IMM to be a grand project with an unlimited potential--a project that is in the national interest and vital to Chicago. To put it simply, just as London for centuries demonstrated the value and power of acting as the world center of financial services, so can the IMM act as the force to make Chicago a financial center for the world.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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